The Power of the PENsion: Pension Contributions – Pay Now or Pay Later?

Every day we are required to make decisions on doing something now or later. Do we purchase airline tickets now or wait for prices fall? Should we start dieting now or wait until after the holidays? With either option, you assume risk: the risk that airline prices go up and the risk that you are limited to wearing sweatpants following the holidays. Similarly, a now or later decision must be made related to pension plan contributions and with each, there are benefits and risks.

Underfunded plans are required by the IRS to contribute a minimum amount each year to improve the funded status of their pension plan. After the global financial crisis of 2008 (GFC) there have been various pension relief measures passed via omnibus legislature (MAP-21, various budget bills) which have lowered contribution requirements. These relief measures artificially increased the discount rate, which lowered the liability, thereby shrinking funding deficits. These measures were intended to be temporary to help sponsors through the GFC, but reducing contribution requirements doesn’t help plans become better funded. These measures have been extended repeatedly by Congress. As a result, sponsors now tend to call the shots on contribution size and frequency, as the IRS requires little or no annual contributions for many plans.

Accounting valuations on pension plan funding are different and have received no such “relief.” From an accounting perspective, reducing contributions only causes an increased funding deficit. De-risking via lump sum payments and annuity purchase or plan termination will track the accounting valuation much more closely. If plan sponsors want to close a funding gap with something other than running off the liability over decades, they’ll need additional cash. Contributing early can take advantage of compounding returns, but that investment of cash siphons it from ongoing operations. Ultimately, funding pension liabilities comes down to a question of pay now or pay later—because pay never isn’t a viable option.

If you’d like to talk further about your pension plan, contact Mike Paolucci, mpaolucci@highlandusa.net or 440-808-1500.